We always thought that the decline in the dollar would come as a result of flows, of a fundamental growing realization that the Ponzi scheme that is being orchestrated by The Fed on global creditors has come to an end. However, it would seem the old specter of geo-politics and sanctions may have usurped fundamentals as the driving force behind a growing de-dollarization. ING Bank states that” 62% of Russia’s goods and services exports to have been settled in dollars in 2019, down from 80% in 2013. Its trade with China was almost all in dollars in 2013; now less than half is. Trade with India, much of it in the sanctions-sensitive defence sector, shifted from almost all dollars to almost all roubles over that period. One reason for this shift, say Russian officials, is that it speeds trade up, since dollar payments can be delayed for weeks as financial intermediaries run sanctions checks.” We used to think that everyone wanted to hold dollars because it facilitated trade and commerce, however given our USA-centric attitude perhaps this shift is becoming more pronounced than one might think.
What I remember most about the GFC (great financial crisis) of 2008/2009 was the amount of sheer surprise regarding who held what, where and for what reason. Money market funds were holding highly risky paper for the slightest pickup in yields, Banks were holding the riskiest, most arcane vehicles for seemingly no real pickup in risk-adjusted return, the list was almost endless and every day seemed to carry a new revelation. It got me thinking about what new surprises will greet us someday, notice we are saying will, not might, timing being the only variable in this discussion. In a general sense, some of the biggest surprises will come where there is a mis-match between perceived liquidity and actual liquidity. The obvious culprit that comes to mind in this regard are the ETF/ETN’s. In 2008/2009 there was an absolute dearth of pricing amongst large portions of the corporate bond market, and this was with the major banks as active participants. Banks are no longer allowed to play in this space, so good luck with two way trade flow among certain ETF’s such as the large High Yield ETF’s when they are hit with selling. The risk is for a feedback loop to start occurring with a liquidity event which could occur in any part of the ETF universe. Selling begets selling which in turn will spill over into seemingly unrelated parts of the Capital Markets.
While listening to a roundtable discussion on negative interest rates and their consequences for real economic growth, I was staggered by the actual statistics in countries employing such tactics. Japan, which has seen negative interest rates off and on since the mid 80’s has seen its banking index fall 85% during this time period. Europe, since employing negative rates post financial crisis, has seen its banking index fall 90% over the ensuing time period. So, when you hear talk of negative rates coming to these shores, be aware that these rates place the entire banking system at risk. Someone needs to remind The Donald that negative rates of interest are not a prize, in fact quite the opposite as they encourage confiscatory practices by Banks which effectively breaks down the entire credit mechanism.
I’m reading a new book out by Amity Shales about the history of the Great Society and its origins and roots in socialism, unions and its aftermath as it spilled into Vietnam and beyond. One thing that stood out for me was that the period after Nixon took the U.S. off the gold standard really marked the beginning of what we now are calling “MMT” (AOC take a look back at your history books sometime). Nixon’s Sunday night move in 1971 to close the gold window was driven by a number of exogenous factors, some of which related to the social programs he was espousing (Yes Nixon). So, deficit-driven spending in close concert with the Central Bank is not anything new under the sun. What followed this period of “freer” dollar float however was new as the U.S. experienced skyrocketing inflation and double digit rates of interest.
Adjectives and narratives in the media, particularly the Financial Media, would have you believe that markets are either soaring or plummeting. There is not much reader (or viewer) interest in the gray areas of meandering, muddling along, or flatlining. However, if you look at volatility almost across all asset classes, it has been stagnant to declining. The question is why? The answer is all contained within the chart above. It may just be a coincidence but the stealth QE instituted in early September has led to a dramatic fall in volatility across capital markets, particularly in equities. It is hard to argue with this chart, particularly as it unfolded against a backdrop of trade talk that could be best be described as unsettling. The Fed has once again swamped the markets with liquidity and in doing so ostensibly eliminated any fat tail risk. For a taste of what’s to come, reread anything written by Nassim Taleb. Spoiler Alert: Its not good.
It seems like the mandatory forecasts for next year keep getting earlier and earlier, but in light of our commentary from years ago and the fact that almost everything from finance to politics to you name it can be categorized in the ” you can’t make this up” category, we have come up with our un-forecast. The un-forecast consists of things which we feel you should actively ignore in the coming year ahead.
- THE FED The credibility of this organization died a long time ago, but in a fitting tribute to our nations only Central Banker who recently passed away (Paul Volcker), you can quit obsessing over the minutiae of Fedspeak and the parsing of words for the purposes of obfuscating what is clearly an asymmetrical policy designed solely to keep capital markets elevated.
- Political Parties and The Economy Ignore the rhetoric around politics and the economy and what one candidate will do or won’t do. The political system in this country is irreparably broken so don’t look to either party as either a panacea for what is broken or a source of practical solutions.
- Arbitrary Environmental Deadlines While we do feel the U.S. decision to pull away from the Paris Climate Accord was more about undoing anything Obama, agreements, accords and pacts like those of the Paris accord, or those involving countries vowing to eliminate combustion engines by the year 2050, etc.. are not about practicality or feasibility but rather about the optics of doing the “right thing”
- Additional QE Ignore the additional QE talk. Its already happening and the Fed is calling it bookkeeping maintenance, whatever they call it, it is funding the budget deficit e.g. Fed’s balance sheet has expanded since this “plumbing problem” surfaced by $297Bln at the same time the deficit has expanded by $260Bln, some coincidence.
The polarization of global capital flows and global trade, a phenomenon unseen in the past 30 years, threatens to upset traditional mores about strict capital allocation and portfolio construction. As capital controls become more commonplace, a situation readily encouraged by the “race to debase”, the incentive to place ones wealth outside the battle lines becomes more pronounced. The question becomes: what asset or asset classes exist a safe distance from this war zone? We believe that the answer to that question will not be so obvious and that relying on historical precedents will not prove much help, however in a general sense those asset or asset classes that are not derived from some current or future sovereign promise to pay most likely is a starting point. As you know we have long been advocates of hard assets as a way to avoid “battle fatigue”, but as I just mentioned, the way forward should not be navigated with an eye towards the past.
In another long line of relative valuation metrics, the market capitalization of Apple Corp. has surpassed the entire market capitalization of the domestic energy industry, including behemoths Exxon and Chevron. The disconnect between the two reminds us of the late 90’s when tech was the only game in town and old school firms, which coincidentally provided the power for said technology, was said to be headed for the trash heap.Todays relative valuation gulf is driven primarily by a belief that the de-carbonization of the global economy is already at hand. Armed with an ESG checklist and a media bias that already has written the obituary for the carbon economy, todays stewards of investment capital are institutionally hamstrung when it comes to pursuing opportunities in the energy sector. The graph above is indicative of the institutional penalty box in which energy finds itself today. However, investment opportunities are most attractive when a large selection of the investment community finds them most “un-investable”.
This good old Texas slight could be used to address most of the U.S. Energy industry, particularly as it relates to returns to shareholders. Non-conventional oil and gas in production in the U.S. has no doubt proven to be a game changer in terms of global petro-dynamics, having implications for everything from Middle Eastern geo-political dominance to shifting margins across a wide disparate of industries. The advent of shale production has undoubtedly cemented the U.S. as the global swing producer, a spot heretofore held by the Saudis, unfortunately for domestic producers, that shift has coincided with a shift towards de-carbonization within the energy sector. These two competing dynamics are taking place against the backdrop of a slowing global economy and its concurrent slowing in global energy usage. The result of all of the aforementioned is that the debt- fueled- growth that has exploded across the entire domestic energy complex has ended in a resounding slump, driven primarily by a lack of sustainable profitability as measured by cash flows. Capital Markets, neither debt nor equity, are willing to continue to finance the” growth- for -growths sake” mentality that has driven the unsustainable ramp in production that has occurred since 2016.
I’ve been reading the biography of Edison recently and the sheer volume and expanse of his creativity and innovation is almost unbelievable. He is credited with over 1093 patents in his lifetime and with the creation of over 100 companies. What struck me however was that he was not only focused on the creative and generative process, but that every “invention” had to be practical and have some economic feasibility. There would be no WeWorks coming out of Menlo Park. It got me thinking about disruption, and the scope and scale of disruption as it exists today versus Edisons day. You can be sure that there were outstanding ideas and inventions that permeated the labs in that New Jersey suburb, but yet never saw the light of day because they weren’t feasible, feasibility as defined by profitability. Contrast this with WeWork, which was neither innovative nor profitable, however in the absence of both was still able to amass substantial investment dollars, that is until the brick wall that always ends such schemes:Financing. Describing the selection of growth over profits WeWork management stated back in the heydays of early March “We can very much, if we chose to, moderate our growth and become profitable,” Artie Minson, WeWork’s president, said in a telephone interview. “But it’s a time for us to continue to accelerate.”